Policy Responses to Aid Surges in Countries with Limited International Capital Mobility: The Role of the Exchange Rate Regime. (May 2015)

• Record Type: Journal Article
• Authors: Berg, Andrew; Portillo, Rafael; Zanna, Luis-Felipe
• Is Part Of: World development. Volume 69(2015)
• Page Start: 116
• Page End: 129
• Publication Date: 2015-05
• Subjects: Africa -- aid -- exchange rate regimes -- reserve accumulation policies -- sterilization policies -- transfer problem; Economic history -- 1990- -- Periodicals; Economic assistance -- Developing countries -- Periodicals; 330.9
• DOI: 10.1016/j.worlddev.2013.12.017
• Languages: English
• ISSNs: 0305-750X

Abstract

Highlights: Study the role of the exchange rate regime, reserve accumulation, and sterilization policies in aid surges. Absent sterilization, a peg delivers similar real effects to those of a float but with higher inflation. Regardless of the regime, policies that result in large reserve accumulation are welfare reducing. Summary: We study the role of the exchange rate regime, reserve accumulation, and sterilization policies in the macroeconomics of aid surges. Absent sterilization, a peg allows for almost full aid absorption—an increase in the current account deficit net of aid—delivering the same effects as those of a flexible regime but with a necessary increase in inflation. Regardless of the regime, policies that limit absorption and result in large accumulation of reserves—are welfare reducing: they help reduce the real appreciation (and inflation under the peg), but at the expense of reducing private consumption and investment, and therefore medium-term growth.